US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets to be sold by rivals under the Treasury’s $1,000bn (£680bn) plan to revive the financial system.

Banks buying assets from each other to inflate their books has nothing to do with “price discovery” or any such nonsense. It’s all about using taxpayer money to create bids that are higher than what the market currently prices those assets at. And if it turns out those bids were too high and the cash flows never materialize then, oh well, it’s the taxpayer left holding the bag.

Spencer Bachus, the top Republican on the House financial services committee, vowed after being told of the plans by the FT to introduce legislation to stop financial institutions ”gaming the system to reap taxpayer-subsidised windfalls”.

Mr Bachus added it would mark ”a new level of absurdity” if financial institutions were ”colluding to swap assets at inflated prices using taxpayers’ dollars.”

You will never stop Wall Street greed and gall unless you legislate it (and even then…). People keep saying that it is the end of an era on Wall Street. My feeling is that it might be, but the end will only be temporary, of course. After all, they repealed Glass-Steagall, and that, in part, led to where we are today. But, if, for some reason, Congress and the international community doesn’t act to firmly regulate the financial industry, we are doomed.

Assume that one of the public-private partnerships the Treasury has promised to create is willing to pay $150 for the asset. That’s 50 percent more than its true value, and the bank is more than happy to sell. So the private partner puts up $12, and the government supplies the rest — $12 in “equity” plus $126 in the form of a guaranteed loan.

If, in a year’s time, it turns out that the true value of the asset is zero, the private partner loses the $12, and the government loses $138. If the true value is $200, the government and the private partner split the $74 that’s left over after paying back the $126 loan. In that rosy scenario, the private partner more than triples his $12 investment. But the taxpayer, having risked $138, gains a mere $37.

Ya got that? 1-to-4 odds for that wager. Stiglitz continues:

What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses.

When the high costs of the administration’s plan become apparent, confidence will be eroded further. At that point the task of recreating a vibrant financial sector, and resuscitating the economy, will be even harder.

With no good options, Obama, while staving off desperation, is courting true, epic disaster. You spell it with four letters and it got us into this mess in the first place.

Last month, the Senate unanimously approved an amendment to the stimulus bill aimed at restricting bonuses over $100,000 at any company receiving federal bailout funds. The measure, which was drafted by Sen. Olympia Snowe, R-Maine, and Sen. Ron Wyden, D-Ore., applied these restrictions retroactively to bonuses received or promised in 2008 and onward.

But then…

The provision was stripped out during the closed-door conference negotiations involving House and Senate leaders and the White House. A measure by Sen. Chris Dodd, D-Conn., to limit executive compensation replaced it. But Dodd’s measure explicitly exempted bonuses agreed to prior to the passage of the stimulus bill.

Here’s the exact language from Dodd’s measure in the stimulus: “The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009…”

How can he possibly explain this?

I have not been impressed with Dodd’s false populist outrage, nor with his disclosure of his role in the unfolding of this crisis. If New York (and London) is the epicenter of this financial earthquake, Connecticut with its hedge funds and insurance industry, represents a second locus of major instability. Dodd, like Schumer, along with the entire GOP, bears serious responsibility for the lack of oversight and regulation preceding these events.

Here is what will happen. They’re furious, everyone is too blame (including Congress), and some CEO (or someone) should give back their bonuses (or something). But, if AIG collapses, the world will truly meltdown and we will all be living in Dubya Towns in the local park.

What should really happen? Richard Shelby (and Chuck Schumer) should be publicly flogged along with every Senator who opposed and worked against appropriate regulation of financial markets. AIG was allowed to be as stupid as they wanted to be because the GOP (and certain Democrats) has fought against regulations and sought to deregulate business and finance at our extreme peril.

I have to say, I am rapidly becoming disillusioned with Obama and the Dems. I think the stimulus is a huge waste of money and will ultimately prove to do more harm than good (not that the GOP tax cut solution was better; it wasn’t). If Obama isn’t going to do the right thing, no one ever will.

I am completely in favor of a cheaper, immediate, short-term burst of stimulus in the form of unemployment aid, state aid, and the like. But this bill is crap and we’re borrowing or printing money to pay for every cent of it. Eventually, we are going to have to cut costs, live within our means, stop borrowing to consume.

Right now, it looks like America is heading for default or hyper-inflation, and in either case, it’s going to look a lot worse than it does today.